Japanese Investment and A Couple of Caveats

There is keen interest in how Japanese investors are going to respond to the new, more aggressive, Bank of Japan monetary policy. Although disappointed that last week's Ministry of Finance data showed that Japanese investors were not only net sellers of foreign bonds, but that they sold the most in a year, market participants have not given up the idea that Japanese investors will be exporting a greater share of their savings. This week's MOF report, which will be released early Thursday in Tokyo, is eagerly awaited. In the meantime, this is the time of year that Japanese insurance companies announce their investment strategy for the new fiscal year. As a group, the insurance companies hold a little more than a fifth of the outstanding JGBs. The other larger holders of JGBs, pension funds and banks, are not so public with their investment intentions. Daido Life, one of the smaller of the Big 9 lifer insurance firms in Japan that dominate the industry, released its outlook for the fiscal year. Others will do so over the next week or two. According to press reports, Daido said that it will slow the pace of its JGB purchases, which appears at least partly forced upon it by the BOJ intent to buy 70% of the new supply. It expects the 10- yield to trade in range of 0.3%-0.7%. That implies that when yields approach the upper end of the range, it will likely be a better buy JGBs. Currently the yield is just below 0.6%. When the yield is at the lower end of the range, it will likely be a better buyer of foreign bonds. It indicated that it will buy more foreign bonds this year than last, but did not say how much more. In the last fiscal year it bought JPY120 bln. In most of the discussions of Japanese purchasing of foreign bonds, little attention is paid to the fact that the currency exposure is often hedged. Daido Life said that it would keep it currency hedge ratio steady near 70%. That means that the demand for foreign bonds is not the same as demand for the foreign currency. It expects the dollar to trade between JPY90 and JPY120 this year and the euro to trade between JPY105-JPY145. Currently, the dollar is near JPY97.80 and the euro is near JPY128.60. There has been much discussion of which foreign bonds Japanese investors will buy. We are suspicious of many claims made by observers of what Japanese investors are currently doing. The country specific flows are reported monthly, but the most recent one covers the month of February. As we already know from the weekly data, Japanese investors were net sellers of bonds in both January and February (weekly data suggest indicates this has continued in March and into April). In the Jan-Feb period, Japanese investors sold almost JPY4 trillion of foreign bonds. US Treasuries accounted for a little more than half of this. Over this two-month period, Japanese investors were net sellers of JPY300 bln of UK gilts. They were buyers of JPY166 bln of German bunds; JPY286 bln of French bonds and JPY900 bln of Dutch bonds. They sold about JPY564 bln of Australian bonds. These are rather modest amounts relative the size of those sovereign bond markets and Japanese investment in foreign bonds. Since then of course, the yen has depreciated and those sovereign bonds have rallied. It is also the start of a new fiscal year. Japanese pension funds typically instruct their asset managers on allocations for the new fiscal year in late April. These new plans begin being implemented often in May. Japanese pension are paid in yen, of course, and pension funds often instruct asset managers to hedge the currency risk of foreign securities. What Kierkegaard said about life, might about to the understanding the Japanese investor: It must be lived forward, but can only be understood backwards. Be wary then of claims of contemporaneous knowledge. Even many banks may only see part of the gross flows and but in this context, net flows are more important. While the purchases of foreign assets may support those asset markets, the direct impact on the currency market may be diluted by hedging, which has often been ignored in discussions of Japanese portfolio flows.